Liikanen-led EU review tells Barnier: do what you were going to do already

By:
Peter Lee
Published on:

The EU's group of high-level experts looking into a reshaping of European banking appears to have lined up alongside those opponents of the banking industry who want to break lenders up and separate retail deposit-taking from casino investment banking. But a closer look reveals their proposals to be less radical than first appears.

The headline recommendations from the high-level expert group that Michel Barnier set up late last year to examine the need for structural reform in EU banking look striking at first sight. They include: mandatory separation of proprietary trading and other high-risk trading activities and possible additional separation of activities conditional on banks’ recovery and resolution plans. The group, chaired by Finnish central bank governor, Erkki Liikanen, looks to be lining itself up as an ideological ally of the Vickers commission, which proposed ring-fencing of retail and investment banking in the UK earlier this year. It also has recommendations on possible amendments to the capital requirements on trading assets and real-estate related loans.

It always struck Euromoney as odd that Barnier should have set up this group to look at the future shape of the banking industry in Europe, after the re-design of key banking regulations according to Basel III had already been signed off by the G20. Wouldn’t it have been more sensible to come up with a core design for the banking system architecture first and then fill in capital, liquidity and bail-in rules afterwards? Barnier seems to have set his cart to trail in long after the horse, having even seen calls for banking union in Europe to be established by the start of 2013, before Liikanen reported.

Co-ordination of reforms

Now his group of high-level experts has released its report, Barnier has no option but to big it up. Barnier says: “This is an important report that will inform our policy on regulating the financial sector. The report underlines the excessive risks taken by banks in the past, and makes important recommendations to make sure that banks work in the interest of their customers". Perhaps aware how much this sounds like a re-statement of the obvious, Barnier insists the report is more than flim-flam: "This report will feed our reflections on the need for further action. I will now consider the next steps, in which the Commission will look at the impact of these recommendations both on growth and on the safety and integrity of financial services. We need to look at these questions also in light of the financial reforms that I have already put on the table of the European Parliament and the Council".

You don’t have to dig too far into the report itself, to find inconsistencies between its rather pedestrian substance and the glaring headline recommendations. While seeming to call for a Glass-Steagall style separation of deposit taking from investment banking, Liikanen rather undercuts this by admitting “In evaluating the European banking sector, the Group has found that no particular business model fared particularly well, or particularly poorly, in the financial crisis”. Rather it blames the crisis on excessive risk-taking often in trading highly complex instruments or in real-estate-related lending, all of which was obvious almost five years ago and for which new capital rules have already been designed to protect the system.

Nonetheless its signature recommendation is that “it is necessary to require legal separation of certain particularly risky financial activities from deposit-taking banks within a banking group”.

Is Europe really going to break up its universal banks at this late stage of the re-regulation process? Apparently, this is not what the high-level group is calling for at all. The last four words of its main recommendation are the key. It simply wants banks to place proprietary and other trading into separate legal entities, presumably making it easier to wind down any failing banks in accordance with existing regulatory requirements to simplify structures and write living wills. The group’s report says: “The long-standing universal banking model in Europe would remain, however, untouched, since the separated activities would be carried out in the same banking group.”

The ring-fencing proposal will attract headlines, but at first read the report looks to be no big deal.